* Walgreen to buy NY-area chain from Oak Hill Capital
* Walgreen to pay $618 mln in cash, assume $457 mln debt
* Deal under CEO Wasson is Walgreen's biggest to date
* Duane Reade to keep name, get $60 mln for remodeling
* Walgreen shares up 0.3 pct (Recasts first sentence, adds lawyer's comments on antitrust issues, analyst comments, updates share movement)
By Phil Wahba
NEW YORK, Feb 17 Walgreen Co WAG.N will buy Duane Reade for $618 million in cash, catapulting the largest U.S. drugstore operator into the top spot in New York City and raising the stakes for rivals like CVS Caremark Corp (CVS.N).
Duane Reade is owned by private equity firm Oak Hill Capital Partners LP and operates 257 drugstores in the New York metropolitan area. Sales totaled $1.8 billion last year and it has the highest sales per square foot in the U.S. industry, according to Walgreen.
"We like their footprint, how it matches up with us," Walgreen Chief Executive Greg Wasson said of Duane Reade in an interview with Reuters. "(It) gives us a leading presence in Manhattan as well as supplements what we have in the boroughs in New York."
The acquisition of Duane Reade is Walgreen's biggest acquisition in its 109-year history as Wasson expands the chain's presence and overhauls stores.
"They have a pristine balance sheet -- it was only six months ago that everyone was asking how can drugstores grow their top line," said Bill Smead, chief executive of Smead Capital Management in Seattle.
Adding Duane Reade will give Walgreen's national market share a slight boost to an estimated 27.7 percent from 27 percent, according to IBISWorld. CVS is close behind, with 26 percent, and Rite Aid Corp (RAD.N) is a distant third with 12.5 percent.
The deal also includes the assumption of $457 million in debt. Oak Hill Capital Partners took Duane Reade private in July 2004 for $415 million, excluding debt, and said the sale to Walgreen "has generated a solid return for our investors."
Once the deal closes, Walgreen will operate more than 300 stores in the wider New York area, a tally Wasson said would put it on par with Rite Aid and CVS in the region, though it would add only about 3 percent to its national store count.
"It would take many years of organic growth to reach the store count that this acquisition brings us," said Wasson, who started as a pharmacy intern at Walgreen in 1980.
Some analysts think struggling Rite Aid, which has suffered eight straight months of comparable sales declines and seen its shares shrivel, could make for an enticing takeover target.
"Rite Aid has market share and its shares are so cheap," said Toon Van Beeck, an IBISWorld analyst, adding that CVS may be under pressure to make an acquisition to quicken growth.
Walgreen shares gained 11 cents or 0.3 percent to close at $34.19 on Wednesday. Rite Aid shares rose 8 cents or 6.1 percent to $1.39.
A GROWTH BOOSTER
Growth in the drugstore industry has been hard to come by. Earlier this month, Walgreen posted a surprising drop in January same-store sales as high unemployment weighed on consumer spending and a boost from the flu season waned. [ID:nN03148337] Rite Aid comparable sales fell 2.1 percent.
Walgreen expects the deal to close by Aug. 31 and to shave 3 cents per share from fiscal 2011 earnings. It sees Duane Reade adding to 2012 earnings per share "by mid-single digits" and potential savings of $120 million to $130 million in the third year after closing.
The deal is subject to approval from the U.S. Federal Trade Commission, but is unlikely to face scrutiny because of the large number of competing drugstores in New York, said Steve Axinn of New York law firm Axinn, Veltrop and Harkrider LLP.
But another expert said the agency could go as far as analyzing individual blocks in New York and force Walgreen to dispose of some locations or assets if the FTC deems they are stifling competition in any specific neighborhood.
"The key question is likely to be the extent to which the two companies are each other's closest competitors," said Paolo Morante, a partner in the antitrust practice at DLA Piper.
DUANE READE TO KEEP ITS NAME
Duane Reade opened in 1960, named after its first location on Broadway, between Duane and Reade streets near New York's City Hall. The company began to overhaul its stores two years ago to update its decor and add walk-in health services.
The chain will keep its brand name and Walgreen expects to retain the employees at its stores and distribution centers.
Walgreen operates 70 stores in the New York area. They include a multi-story flagship store opened in 2008 in Times Square, across the street from a Duane Reade, to show the Deerfield, Illinois, chain had designs on New York.
Wasson said there are no plans to close either Times Square store, but the company said in a statement Wednesday that it would decide over time how "to harmonize" both chains. It also plans to spend $60 million in the next few years on new Duane Reade stores and remodels of existing locations.
Walgreen has opened most of its more than 7,160 stores on its own. While it has pared back its rapid store openings, it still opens hundreds of stores a year.
In late 2008, Walgreen started sprucing up stores with lower shelving, fewer items and better signs to help consumers find what they need, under a program the company dubbed its "CCR" program, for customer-centric retailing.
Peter J. Solomon Co. was financial adviser to Walgreen and Wachtell, Lipton, Rosen & Katz served as legal counsel. Goldman Sachs & Co and Bank of America Merrill Lynch were co-financial advisers to Oak Hill and Duane Reade, with Paul, Weiss, Rifkind, Wharton & Garrison providing legal counsel. (Additional reporting by Jonathan Stempel, Jessica Wohl and Megan Davies and Diane Bartz; Editing by Michele Gershberg, Tim Dobbyn and Matthew Lewis)